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Is American cowboy capitalism causing unnecessary pain for the U.S. equity markets? Fragmentation of order flow is possibly the worst sign of strain.

A lance corporal of the U.S. equities markets is miffed the U.S. hasn't learned a valuable lesson from European centralized stock market trading. The newest American enemy is electronic communications networks.

"You don't see ECNs in Paris, Frankfurt, or Zurich or even in London, which is moving towards a much more efficient market," said Doug Atkin, the youthful chief executive of Instinet, at a recent press conference.

(Instinet, a subsidiary of Reuters Group, squirms at being labeled an ECN. That's even though it is technically an ECN, and the largest of the eight approved ECNs, as measured by single-counted share volume.)

A coming shoot-out at the OK Corral, therefore, might be a suitable metaphor for what is likely to occur in the years, if not the months ahead. Far-fetched? The suddenness may be as brutal on some participants as recent federal regulations have been for market makers.

"ECNs will be a short-lived pheno-menon," says a report on ECNs by Meridien Research in Newton, MA. "Eventually, fully electronic, order-driven stock exchanges will appear in the U.S. Nasdaq is clearly moving in this direction."

Though the Meridien report is unkind, with cutting cliches, regurgitating Securities and Exchange Commission handouts on how market makers allegedly engaged in price collusion, the picture it paints of the post order handling rules environment is not reassuring for traders.

(Yes, the academic evidence of ill-gotten gains on Nasdaq is overwhelming. A libertarian economist, however, might consider the subsequent federal order handling rules, installed to clean up Nasdaq, a form of insidious price control straight out of a socialist monetary textbook.)

The order handling rules, the report underscores, unleashed the whole sorry mess of ECNs that are fragmenting the marketplace today. The irony, of course, is that these rules, designed to speed up the centralization of the U.S. equity markets - and to prevent market makers from "shelving" unprofitable limit orders - are encouraging the opposite.

ECN Growth

Together, ECNs will attract and match an increasing proportion of Nasdaq order flow in the years ahead, according to Meridien. By 2001, the research outfit projects that ECNs will account for about 50 percent of Nasdaq trade volume. But the unification of disparate market centers may be looming.

"The number of ECNs will not remain at the current level," Meridien notes. "We expect to see significant consolidation because stock exchanges tend to be something economists refer to as "natural monopolies."

"Investors will naturally gravitate to the largest exchange, because that is where the greatest liquidity is, and where they are most likely to find a counter-party willing to trade at the best possible price. The same logic applies to ECNs - users will gravitate to the largest ECN."

The rationale is clear: a consolidating ECN industry will tussle with the New York Stock Exchange and Nasdaq and some marriages of convenience will occur. Instinet and other ECNs have all recently danced jigs with the Big Board and Nasdaq. The most publicized partnership talks centered on Instinet and the Big Board.